What Valuation Models Do Analysts Use?

ACCOUNTING HORIZONS Vol. 18, No. 4 December 2004 pp. 221-240

What Valuation Models Do Analysts Use?

Efthimios G Demirakos, Norman C. Strong, and Martin Walker

SYNOPSIS: This paper adopts a structured positive approach to explaining the valuation practices of financial analysts by studying the valuation nfiethodologies contained in 104 analysts' reports from international investment banks for 26 large U.K.-listed companies drawn from the beverages, electronics, and Pharmaceuticals sectors. We provide a descriptive analysis of the use of altemative valuation models focusing on the value-relevant attributes that analysts seek to forecast and the methodologies analysts use to convert the forecasts into estimates of firm value. We postulate and test a number of hypotheses relating to how the valuation practices of analysts vary systematically across industrial sectors. We find that: (1) the use of valuation by comparatives is higher in the beverages sector than in electronics or Pharmaceuticals; (2) analysts typically choose either a PE model or an explicit multiperiod DCF valuation model as their dominant valuation model; (3) none of the analysts use the price to cash flow as their dominant valuation model; and (4) contrary to our expectations, some analysts who construct explicit multiperiod valuation models still adopt a comparative valuation model as their preferred model. We believe the study's findings are important for increasing our understanding of the valuation practices of financial analysts. The study also provides a basis for further research that tests a richer and more detailed set of hypotheses. Data Availability: A list identifying the sampled analysts' reports is available from the authors. The reports themselves are publicly available from the Investext database. INTRODUCTION aluation theorists have studied the theoretical properties of several valuation frameworks, and some authors use these theoretical properties to produce normative arguments...